Could attitudes to retail be about to change?

Edinburgh St James:
Nuveen is backing this mixed-use development in Scotland’s capital

No one wants to invest in retail real estate. That is the message conveyed by PERE data for retail-specific fundraising in the fourth quarter of 2018 and first quarter of this year, writes Stuart Watson.

Around the globe during that period no capital was raised and no funds closed. Zero. Of course, the situation is much more complex and nuanced than that bald figure suggests, but it does reflect the overwhelmingly negative sentiment surrounding the asset class at present.

For some time now retail has been supplanted in investors’ affections by logistics and residential. Sector-specific fundraising for those asset classes totaled $11.5 billion and $11.2 billion in 2018 respectively, dwarfing retail’s total of $2.4 billion. Can the outlook for the sector really be that bleak? Or could the tide be about to turn?

Fundraising figures for the second quarter of 2019 will at least be boosted by the $800 million final close of Charlotte, North Carolina-based Asana Partners’ retail-focused Asana Partners Fund II. Looking back a little, other retail funds have met their capital-raising expectations: in July last year Sterling Organization, a Florida-headquartered retail specialist, raised $495 million for a value-add fund, and London-headquartered investment manager Meyer Bergman closed its Meyer Bergman European Retail Partners III fund at the beginning of 2018 having netted €816 million.

Meyer Bergman’s founder and CEO, Marcus Meijer, is at pains to point out that vehicle is actually a mixed-use fund, however, and includes no shopping centers. “In hindsight we probably should have dropped the ‘retail’ for fund three,” he says.

The company’s fourth vehicle, for which it is raising capital at present will go by the title of an “urban real estate” fund, and, like its predecessor, will include logistics assets.

“If you come to a meeting and people think that you are going to talk about a retail fund – even if, like us, they think there are still opportunities in retail – the mandate from their CIO and executive board often says that retail is not a strategy that they want to allocate to right now,” observes Meijer.

Declining activity

The cost pressures and competition from e-commerce that have afflicted brick-and-mortar retailers are well-attested, and that negative perception is reinforced on an almost daily basis by news of major chains retrenching or going bankrupt. Moreover, many investors worry that they are over-exposed to the asset class already, says Meijer: “A lot of them are sitting on shopping centers that have fallen in value quite significantly, and a lot are holding stock in the REITs like Hammerson, Intu, Klépierre and Unibail-Rodamco-Westfield, the value of which has also been declining, but they can’t sell at prices that are anywhere close to those at which they would consider selling.”

Chris Gardener, head of European retail investment at brokers CBRE, has noted a “vast reduction” in market activity at the end of 2018 and start of this year. His firm calculates that total European retail investment was €12.8 billion in the first quarter of 2018, but only €6.7 billion in the corresponding period this year. “With fewer buyers in the market and declining liquidity, owners of retail real estate find themselves in a position where it often makes more sense for them to hold on to their portfolios and refinance them rather than exit,” he says.

A similar pattern has emerged in the US, says Garrick Brown, head of retail research for the Americas at consultant Cushman & Wakefield: “We have seen about a 50 percent decline in investment activity. The buyer pool has shrunk and they generally chase after class A and trophy assets, but the current owners don’t want to sell.”

Nevertheless, some managers still believe that they can find value in some corners of the asset class. The mood music surrounding retail has led to some institutional investors “throwing the baby out with the bathwater,” argues Sterling Organization president and CEO Brian Kosoy. “There is more capital leaving the space than coming into it, which is pushing prices down, while the capital coming into the space is focused on very specific product types, which has created a bifurcated market. The spread between core gateway market properties versus non-core secondary assets is as big as I have ever seen.”

Kosoy remains cautious about shopping centers: he estimates that perhaps 500 of America’s 1,200 or so covered malls will not survive the current turbulence. However, he believes that it is still possible to make double-digit returns by buying fundamentally sound real estate in out-of-favor categories like neighborhood and power centers in strong markets with low and defensive rents.

Good opportunities

If you are going to invest in shopping centers, it is important to own the best, observes Myles White, head of retail for Europe at global investment manager Nuveen Real Estate.

“Large-scale prime experiential retail, which is often located in the more dominant malls has a very strong future, particularly where there is a strong tourist base or food anchor,” he says.

Nuveen is one of the few investors backing major development in the sector at the moment, and is committed to delivering the 1.7 million-square-foot Edinburgh St James mixed-use project in Scotland.

White is also bullish about the designer outlet sector. “Outlets have been the strongest performing of our retail investments across all our different funds.
That has been because of a combination of consistent income, growth in income and improving cap rates,” he says.

Nuveen has formed joint ventures to invest in and develop outlet centers in Europe and in China. “That is offering the Chinese consumer the same experience they get in Europe with the same theater of building with a guarantee of origin of the goods. It also follows the trend of the creation of wealth in countries like China and the growing ability for them to spend that wealth.”

Meijer says there are still good opportunities in high-street retail, but only where rents are affordable: “If you are in a location where there is footfall, tourism and a well-developed retail environment there is still demand from retailers, but only when they feel they can make good money from that store. In places where rents have been pushed too high – London, New York and Los Angeles are generally over-rented, more so than cities in continental Europe – you have to wait for the rents to come down to more realistic levels to start investing again.”

In some areas of the market, notably secondary shopping centers, liquidity is close to drying up altogether. Opportunistic investors are poised to call the bottom of the market and snap up redevelopment and repositioning opportunities. Few have so far taken the plunge, though. The asset class may have reached its nadir, but concerns remain that it may still have further to fall.

In the meantime, however, people will continue to buy goods and retailers will need stores from which to sell them. Kosoy argues that in a period of rapid technological disruption it is unfair that retailing has been singled out.

“The world is changing fast in relation to all industries, but for some reason retail has become a poster-child for that change,” he says. “A lot of that is because of Amazon, but tell me what the auto or entertainment industries will look like in 20 years. Who knows? At the end of the day, good real estate is good real estate.”